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CFA Institute Research Challenge

hosted by
IAIP (Indian Association of Investment Professionals)
Team: Francesco D'Andrea
Exchange: NSE Sector: Private Sector Banks

Ticker Symbol: HDFCBANK Industry: Banks

SELL
Target Price Rs.583
RELATIVE
PERFORMANCE
RETURN GROWTH
Current Price <19 Oct 2012> Rs.628

Downside 7.2%
VOLATILITY P/BV

HDFC BANK : PRETTY BUT PRICEY


FINANCIAL RATIOS
We initiate coverage of HDFC bank with a sell rating and an end-of-the
Book value per share 127.52 year target price of Rs 583, which offers a 7.2 % downside from current
stock price.
EPS 22.02
Dividend per share 4.3 HDFC bank, 24% owned by HDFC, has a network of more than 2,620
Dividend yield 0.68 branches and 10,316 ATMs in 1,454 cities making it the second largest
private sector bank in India. Stable CASA ratio (46%) and NIM (4.2%) has
ROE 18.69 led to consistent profit growth for the last 10 years. We expect HDFC
ROA 1.68 Bank to deliver 20% CAGR in net earnings over FY13-15E, aided by NII
growth, despite our concerns on higher delinquency rates.

A strong performer - HDFC bank is one of the best banks in India and we
MARKET DATA could find little fault with its strategy or management. HDFC banks net
revenues were at 5,076.8 cr for the quarter ended September 30, 2012,
Market Capitalization(Rs. Cr) 137566
an increase of 22.2% qoq. Net interest income grew by 26.7% qoq. This
53 wk H/L (Rs.) 639/400 was driven by loan growth of 22.9% and a NIM for the quarter of 4.2%.
The bank has always given excellent numbers on growth, profitability and
Avg. Vol. (3 m avg) 194204
asset quality.
Free float (%) 76.90%
Circuit Limits 762.35/508.25 Growth to moderate - With its strong fundamentals, HDFC bank would
continue to grow. However we expect the growth to moderate in the
Face Value (Rs.) 2 years to come and given the size of the bank (increasing base) the
NSE code HDFCBANK historical growth levels of assets and profits of 30% CAGR are difficult to
sustain. In addition moderation of growth in Auto sector (40% of retail
BSE Scrip Code 500180 loans), slower growth on CASA as the bank is concentrating on rural and
FORWARD 12 m RATIOS: semi urban areas (70% new branches in FY11 and FY12) and expected
increased delinquency rates would put pressure on growth. The level of
P/BV 4.25 competition from private banks targeting the same space on the assets
P/E 23.84 and liability side is also increasing. Based on above analysis, we expect
the profits to grow at a CAGR of 20% plus in FY13E to FY15E and assets
P/Total Assets 0.0015 to grow at a CAGR of 18% in FY13E to FY15E.
BVPS 148
Valuation - Our valuation methods lead to a target price of Rs 583 by
Source: NSE, Team Estimates end of FY13. We still reiterate that HDFC bank is fundamentally a very
strong company but current prices more than reflect all the positives.
HDFC Bank has always commanded a premium valuation vis-à-vis its
peers due to its track record of consistent growth in earnings and
HDFC and BANK NIFTY assets. But the present multiple of 4.9x P/B is not justified by the
financials and we expect it to correct going forward. The stock currently
trades at 4.2x FY13 adjusted book value.

Investment Risks - The major upside risks on the target price are 1)
stable or improved NPAs 2) stronger growth on retail book on account
of HDFC outwitting the competition by new private sector and 3) PSU
banks with stable growth in CASA.
Source:Moneycontrol.com
1
Investment Summary

Consistent earnings and quality business but expensive valuation - HDFC bank is a consistent performer in the Indian
banking sector and has distinguished itself from the rest of the pack consistently. The bank’s FY13 Q2 numbers were
in line with our expectations and going forward we expect slight pressure on account of increase in delinquency,
moderation in CASA, increased competition from private & public sector banks and moderation in other income.
Considering its superior business quality, its relative value compared to its peers is most obvious during challenging
times. However, given that its current valuations are above the intrinsic value and the multiples well above the intrinsic
levels, we expect the stock to moderately correct from current levels. The stock has had an excellent run up in the near
past and has consistently outperformed both the Nifty and the sectoral index. We expect the prices to correct and the
stock to trade at its long term average 1 year forward P/ABV multiple of 3.9x which gives a target price of Rs 583.

Concerns amid strong fundamentals - Although the bank’s business looks formidable with strong fundamentals and
the bank has given excellent performance numbers, we believe current valuations more than reflect these positives,
but ignore risks. We see the following key risks going forward: a) The past performance of the bank could prove to be
an impediment for it in the future. With the high base, the growth in assets and operating profit at historical levels of
30% looks difficult to sustain. We expect a likely slowdown in asset growth and operating profit to mean levels of 20%
on an average. b) potential downside to profitability due to increased competition from private and public sector banks
which target the same business (as the other focus sectors like infra have nearly dried out) and increased delinquency
rates on account of unfavourable macroeconomics. c) moderation in CASA growth at around 16% levels compared to
its own excellent past growth numbers, as market share stagnates due to expansion of branches in lower yielding
rural/semi-urban areas and competition from smaller banks that are expanding at a faster pace.

According to our estimates, we expect HDFC bank to trade in the 3-4x P/BV band in the longer term. Any valuation
which offers an upside from current expensive levels would depend on a sustained ROE improvement outlook over
20%+ or an extremely favourable macro condition, which we do not foresee in near term.

The key upside risks to our target price lie in: (1) any positive news on asset quality; (2) sudden revival in the economy
due to turnaround in macro environment; (3) more than expected growth in loan book of the bank in spite of sluggish
economic outlook; and (4) changing risk perceptions of private banks and they getting perceived as less riskier
compared to public sector banks. If any of these factors has a greater impact than we expect, the stock could have
difficulty achieving our target price.

2
Business Overview

Shareholding Pattern Incorporated in the year 1994, HDFC Bank commenced operations as
a Scheduled Commercial Bank in January 1995. HDFC bank is
headquartered in Mumbai and is promoted by HDFC - India's premier
Promot
er housing finance company. HDFC Bank has had strong and steady
Others growth over the past 10 years and continues to grow at more than
23%
35%
25%. HDFC Bank acquired Times Bank in 2000 and Centurion Bank of
Punjab in 2008.

The Bank at present has an enviable network of 2,544 branches


DII FII spread in 1,399 cities across India. The Bank also has 10,235
10% 32% networked ATMs across these cities. HDFC Bank's mission is to be a
World-Class Indian Bank and it has been continuously progressing
Source: NSE India, Team Estimates towards achieving its mission and today with a total business of 4.5
lakh cr, it is the 2nd largest private sector bank in the country. Along
with achieving excellent returns (ROA of 1.68% and ROE of 18.69%) for
Mar-
Mar-09 Mar-10 Mar-11 12 all its stakeholders, the bank has always maintained the highest level
of ethical standards, professional integrity, corporate governance and
Cities 528 779 996 1399
regulatory compliance.
Branches 1412 1725 1986 2544
HDFC Bank offers a wide range of commercial and transactional
ATMs 3295 4232 5471 8913 banking services and treasury products to its wholesale and retail
Source: Annual Report customers. The bank has three key business segments: Wholesale
Banking Services, Retail Banking Services and Treasury. Together they
New offer a complete suite of products to meet diverse customers`
Pvt requirements.
ROA Banks
Avg HDFC banks has two subsidiaries
2
1.5 HDFC securities Limited - a leading AAA / Stable (CRISIL) rated
1 brokerage firm offering integrated financial solutions for both retail and
institutional investors. HDFC bank holds 63% ownership interest in
All Pvt 0.5 All
HDFC securities.
Banks 0 SCB
Avg Avg HDB Financial Services - a leading Non Banking Financial Company
(NBFC) that offers customized financial solutions to both retail and
commercial customers which include asset backed loans, Loans for
personal and business purposes, Commercial vehicle loans, life
Source: RBI website,
HDFC Team Estimares insurance and general insurance etc. HDFC bank holds 97.4%
Bank ownership interest in HDBFS.

HDFC bank also has ownership interest in two associates, Atlas


Business Comparison Documentary Facilitators Company Private Limited (29.0% stake) and
International Asset Reconstruction Company Private Limited (29.4%
All Pvt Banks Avg HDFC Bank
stake).
All SCB Avg New Pvt Banks Avg
HDFC bank has always stuck with a predominantly non price strategy
5,87,294 model because of the existing regulatory framework and the
complementarities built into the system. But because of its excellent
Deposits

24,67,064
7,50,426 management, impeccable execution, product and technological
1226708. innovation and excellent asset quality, the bank has been a consistent
623
performer over the last 10 years with strong growth in profit (bottom
4,83,209 line growth of over 30%), high profitability (ROE of over 17%) and low
Advances

19,54,200 NPLs (GNPA of 0.9% and NNPA 0.18%). The bank has achieved pre
5,90,067 provisioning operating margin growth at 35% & 28% CAGR over the last
1051890.
10 & 5 years & PAT at 33% & 35% respectively.
677 Source: RBI website,
Team Estimares

3
Industry Overview (see Appendix 1)

Banking in India is resilient, however, under extreme shocks, some


Demographics - boost to Retail Banking banks could face moderate liquidity problems and their profitability
could be affected. The banks in India have been found to be deeply
AGE: Below 20 20-50 50 and above interconnected, which can bring about magnification of shocks. The
threat of contagion is relatively lesser due to RBI regulation on
50 51.1
45.144.7 interbank exposure.
38.2 36
Asset quality management Net NPAs for the private banking sector
16.3 17.9 have been falling since 2008-09, however, we notice that that rose
13.9
during crisis period. There is a possibility of NPAs rising going forward.
Also, rising SME loans in their portfolio tend to be sticky and can be
harmful in a volatile interest rate scenario.
2001 2011 2016
Source: Census of India, Team Estimates
Favourable Demographic trends point towards an increase in demand
Bank credit (as a % of GDP) for retail as well as other banking services. Retail banking will benefit
80 due to a demographic shift to a younger and larger labour force and
emergence of a large middle class, increasing demand for affordable
70 and accessible banking. Also, households earning more than Rs.
500,000 per annum are expected to grow the fastest, thus raising
60
demand for wealth management and other allied facilities for HNIs.
50 Having said this consumption growth has weakened given the fall in
real incomes. (See Appendix 1 A)
40
Increased pressure on NIMs is anticipated by the banking sector due
Source: Google Public Data to the increase in competition. This implies greater dependence on
fee incomes and other sources of revenue generation like cross-
selling. Cross-selling will emerge as a very important source of
Financial Products available per customer revenues because this potential is relatively untapped in India
compared to global benchmarks.
Global best practices
benchmark range
Credit Growth and GDP: Recent fuel price hikes and inadequate rain
Public Banks are likely to exert upward pressure on inflation rate. There are also
misgivings about the inflationary impact QE 3 would have on
commodity prices. To keep inflation in check, the RBI is less likely to
Foreign Banks
lower policy rates any more in the immediate future. 2013 GDP
growth forecasts have been revised downward to 4.9-5.3%, with the
Private banks IMF giving a conservative number of 4.9%. It has been observed that
Source: IBA-FICCI, the banking sector grows at about a 2.5 multiple of the GDP growth.
Team Estimates 0 2 4 6 8 We put the expected growth figure in the range 12.25%-13.25% for
the sector.
16000 180
BANKEX
160
Sectoral Impacts: In Power, The CCEA has approved a restructuring
14000
plan for State Electricity Board loans through bank credit, Bank credit
WPI 140 to the the sector rose to 7.2 % of all bank lending in March 2012. SEB
12000
120 discoms have doubtful repayment ability. In Auto, High inflation,
10000
100 economic uncertainty and high fuel prices led to the steepest monthly
8000 fall in 4 years in auto sales in September 2012 .
80
6000
60 Bankex and WPI The Bankex and the WPI show a strong positive
4000 40 correlation. However, we observe that the Bankex or inflation tends to
move about the WPI in the short run. In other words, we see the
2000 20
Bankex coming back to the WPI line after deviating in the short run.
0 0 We expect Bankex to rise in the medium run as the inflation is not
Dec-04

Dec-07

Dec-10
Sep-05

Sep-08

Sep-11
Mar-04

Jun-06
Mar-07

Jun-09
Mar-10

Jun-12

expected to come down due to the aforementioned factors.

Source: BSE, Team Estimates

4
Competitor Analysis (see Appendix 2)

ROA% 5year 3year 2year 1year HDFC Bank is highly valued by the markets on account of (1) consistent
HDFC Bank 1.51 1.57 1.63 1.68 growth (2) Asset quality which withstood during economic downturn (3)
Qualified and Performance driven management. However analysis of
ICICI Bank 1.19 1.30 1.41 1.47
the ratios reveals that HDFC Bank is not the lone bank with these
Axis Bank 1.46 1.58 1.61 1.61 qualities.
Yes Bank 1.51 1.52 1.47 1.42
Private sector banks like Yes Bank and Kotak Mahindra bank fare better
Kotak 1.52 1.80 1.86 1.86
Bank than HDFC Bank on parameters like ROA, ROE and % growth in
SBI 0.93 0.85 0.82 0.91 deposits. Though the GNPA ratio of HDFC Bank is at all time low, it is
HDFC Bank has the most favourable CASA deposit ratio at 48.4%,
however this is a 8.8% decline from FY11 on account of cannibalization
ROE% 5year 3year 2year 1year
of CASA deposits to term deposits which offered attractive interest
HDFC Bank 17.33 17.25 17.72 18.69 rates. The growth in CASA deposits for all the big banks is much lower
ICICI Bank 9.68 9.61 10.43 11.20 as compared to the new generation banks as their asset base and
reach is very high.
Axis Bank 19.10 19.59 19.82 20.29
Yes Bank 20.82 21.49 22.10 23.07 The Bank's performance on per employee basis is the lowest although it
Kotak 12.32 14.25 14.61 11.37 has been improving over the years. Ratios such as Profit per employee,
Bank Business per employee are the lowest and the bank has a long way to
SBI 15.39 14.38 14.17 15.72 catch up. Wages as a percentage of total expenses is one of the highest
Source: Annual Report, Team Estimates in the industry.

Source: Annual Report, Team Estimates


Business
Growth in Growth in Profit per Wages as
per
GNPA % 5year 3year 2year 1year CASA Business CASA Ratio % employee % Total
employee
Deposits % % (in lacs) Expenses
(in lacs)
HDFC Bank 1.37 1.16 1.03 1.02 18.40 19.96 48.40 8 669.1 14.42
ICICI Bank 3.75 4.06 3.85 3.58 9.20 11.44 43.50 9 2273.3 11.47
Axis Bank 1.05 1.13 1.07 1.04 16.30 17.54 42.00 14 1228.0 10.41
Yes Bank 0.30 0.24 0.22 0.22 71.50 8.52 16.30 20 1544.5 8.45
Kotak Bank 2.17 1.70 1.49 1.29 41.00 30.70 32.20 9 799.5 16.4
SBI 3.03 3.36 3.64 4.18 14.10 13.99 46.60 5 1196.6 19.01
The five forces Score Rationale
Porter's 5 Forces Model The Brand name HDFC coupled with the
Bargaining power fact that it's one of the industry
2
of suppliers leaders, leads to a low bargaining
Bargaining power of suppliers
HDFC faces tough competition
power of from the other top banks. For almost
suppliers Threat of
4 every HDFC product, there is a substitute
4 substitutes
in ICICI and to a great extent in Axis as
well
2 Threat of
Industry rivalry HDFC is a leading bank providing world
substitutes Bargaining power class facilities which acts as a
0 3
of customers benchmark. However, other banks are
adept at innovating to attract customers.
Bargaining
Threat of new
power of Threat of new There are high regulatory barriers to
entrant 2
customers: entrant entry

Source: Team Estimates The industry sees a tough competition


Industry rivalry 3 from its peers which are equally well
placed.

5
Financial Analysis:
Operating performance and revenue:
NII & PAT
Robust Revenues - FY12 has been characterized by strong growth in revenues
25000
at CAGR 22% over last 5 years, primarily driven by an increase in both net
NII PAT
interest income and other income. Non Interest Income has grown at a steady
20000 rate of 22% on account of growth in Fees & commission, foreign exchange &
derivative commission and Gain/Loss in revaluation or sale of investment.
CAGR~20.72%
15000 HDFC Bank has increased its focus on the 3 mentioned areas, as it contributes
to about 20% of their total income.

10000 CAGR~26.08% We expect a growth of 20% in Interest earned during FY13 to FY 15 on account
of
5000
-Interest on advances will grow at 10-10.25% of Net Advances, in comparison
to a growth of 10.5% in FY12 on account of an expected decline in the growth
0
of both retail and wholesale loan book.

-Growth in income from inve stment will be in line with F Y12 at


Source: Annual Report, Team Estimates 6.6% of Net investment. This leads to a growth of 23 -30% growth
in income from inve stment. -Interest on investment with RBI and
Banks are on short term bas is and hen ce it is ass umed to be the
same as in FY 12.

Non Performing Assets -Interest on investment with RBI and Banks are on short term basis and hence
it is assumed to be the same as in FY 12.
2.5% 100%

82.51% 80.48% 90% -Growth in Non interest Income is expected to be 16-18% with major growth
1.95% 78.76%
2.0% 78.42% 80% seen in fees and commission. Other income is expected to remain at 20% of
82.38%
79.51% 70% total income earned due to increased focus of Bank to expand in this segment.
68.43%
1.41%
1.5% 60%
Weaker Margins : Interest expense increased sharply in FY11 on account of
1.14% 1.19% 50%
1.05% 1.02% 1.05% increase in saving deposit base interest rate from 3.5% to 4%. This caused the
1.0% 40% cost of funds to increase from 4.21% to 5.54%. In Nov 2011 RBI deregulated
0.63% 30% savings interest rates; however most of the banks have not increased their
saving interest rate. HDFC bank has a stable margin of 4.2%, however we expect
0.5% 0.31% 20%
0.19% 0.18% 0.21% 0.24%
0.25% it to subside to 4.06% in FY13 and subsequently, increase to 4.29% in FY15.
10%
0.0% 0% Net Profit expected to weaken– Bank’s net profit rose to Rs. 5167.1 cr from Rs.
3926.4 cr, rising by over 31% in comparison to 15% growth in pre-provisioning
operating profits. This was on account of low provisioning in FY12 due to growth
GNPA(%) in healthy assets leading to lowering of NPA levels. The bank continues to
NNPA(%) maintain 80% provision coverage ratio. The EPS rose by about 30% from Rs. 17
Provision Coverage Ratio per share to Rs. 22.11 per share.
Source: Annual Report, Team Estimates
Our projections for FY13-15 show the growth in pre-provisioning operating profit
to be 20% which is in line with the growth over the past few years. However due
to increased wholesale loan exposure to perceived sensitive sectors, we expect
the NPA levels to increase marginally from historic low levels; this calls for
higher provisioning.

Bank's exposure to sensitive sectors (as of March 31, 2012)


As a percentage of total exposure
Commercial Capital Iron and
Power Roads Telecom Textile Total
real Estate Market Steel
HDFC Bank 2.2% 6.1% 1.0% 2.9% 3.4% 0.9% 1.9% 18.3%
ICICI Bank 5.4% 5.7% NA 5.5% 4.7% 0.7% 4.1% 26.2%
Axis Bank 3.3% 2.0% 1.2% 4.7% 2.0% 1.8% 2.3% 17.3%
Yes Bank 3.0% 4.7% 1.4% 3.7% 1.1% 0.4% 1.6% 15.9%
Kotak Mahindra Bank 3.6% NA NA 9.6% 2.0% NA 0.2% 15.3%
Source: Annual Reports

6
CASA & Term Deposits Dividends - The Bank has a defined policy of distributing 20-25% of its PAT as
120% dividends to its shareholders.

100% 44.37% 52.69% 46.47% 45.31%


45.82% Balance sheet and financing:
52.03% 48.40%
80%
As on March 31, 2012, HDFC Bank’s total balance sheet size was Rs. 337,909
60%
cr an increase of 21.8% yoy over Rs. 277,353 cr as on March 31, 2011.
40%
20% Total Deposits increased 18.3% from Rs. 208,586 cr as on March 31, 2011 to
Rs. 246,706 cr as on March 31, 2012. Savings account deposits grew by 16.6%
0%
to Rs. 73,998 cr while current account deposits were stagnant at Rs. 45,408 cr
as on March 31, 2012.However CASA deposits stood at 48.4% of total deposit,
down from 52.7% in FY11.
Term Deposit (%) CASA(%)
Our expectation for FY13 is a growth of 15% in Demand deposit, 16-18% growth
Source: Annual Report, Team Estimates in Savings deposit and a 20% growth in term deposit. This will lead to CASA
deposits reducing to 45% levels .FY13 will see a continuing shift towards term
Loan Book Mix deposits as the interest rates are not expected to subside significantly.
58.18% 61.01% 56.79% 49.65% 54.41%
100%
Bank’s loan growth was driven by an increase of 33.7% in retail advances to Rs.
80% 107,126 cr, and an increase of 10.5% in wholesale advances to Rs. 89,764 cr.
Advances are expected to improve by 20% YoY due to increased focus on
60%
growing the retail loan book . However other private sector banks like Axis bank
40% and ICICI bank have now shifted their focus on growing their retail loan portfolio
20% which would result in moderation of HDFC bank’s loan book. The Bank has a
market share of 3.9% in total system deposits and 4.3% in total system
0% advances. The Bank’s Credit Deposit (CD) Ratio was 79.2% as on March 31,
FY08 FY09 FY10 FY11 FY12
2012 and is expected to improve to 79.54% by FY15.
Wholesale Loan Book Retail Loan Book
Source: Annual Report

Valuation (see Appendix 3 and 4)


We initiate the coverage of HDFC bank with a SELL rating and a price target of Rs 583

HDFC Bank has outperformed its peers over the last few years in terms of high
Growth in Deposits & Advances NIM(4.2) , low NPA(net NPA 0.2%) and growth in EPS(30%) .However due to
Deposit Advances deteriorating macro economic conditions and the expansion of the bank into
semi urban areas , we believe that there will be an incremental increase in NPA
Credit Deposit Ratio
levels which will exert pressure on the bottom line . A valuation of P/ABV of 3.9x
4,50,000 82% and P/E of 22x in FY 2013 are a result of the following expectation:
4,00,000 80%
3,50,000 78% -Decrease in growth of CASA deposits as the bank has opened around 70% of
3,00,000 76% the new branches in Tier II to Tier VI cities. The growth in deposits from these
2,50,000 74% new branches will be lower than traditional values as these branches will have
2,00,000 72% lesser number of transactions and also a lower balance.
1,50,000 70%
-Increasing competition from new private sector banks as they are expanding
1,00,000 68%
rapidly, especially in the urban areas. This will put pressure on the already
50,000 66%
stable and dominant banks.
0 64%
-Increase in NPA levels from historic low levels which will be difficult for the bank
to maintain. We expect slippage to increase by 10 bps in comparison to 0.81%of
Source: Annual Report, Team estimates
net advances in FY12.

7
V aluat ion:
SOTP Valuation Methodology
Particulars Basis Multiple Stake(%) Value We have valued the stock using 3 methods: Residual Income method, Gordon
growth Model and Relative valuation. The Residual income analysis is based on
RI and sum of parts method where we have valued the main business of the bank and
HDFC Bank Gordon 3.5x 100% 589 its two subsidiaries HDFC Securities (HDFCsec) and HDB Financial services
Growth separately. We have followed this approach as the two subsidiaries are
HDFC relatively small in size and the risk in their line of business is very different from
Securities
DCF 63.02% 2.17
the parent bank.
HDB Gordon
97.03% 2.13
Financial Growth
Res idual Income method:
Total Value
Rs.
of HDFC
Bank 593 The value per share using two stage residual income method is Rs 583. The
methodology followed to arrive at the intrinsic price is as follows:
COMPONENTS OF A TWO STAGE GORDON
GROWTH MODEL
ROE 18.69%
High growth period 25
Payout for 25 years 20%
Profit after Tax (PAT) : The growth in PAT is estimated to be around 20% YoY
Growth rate for 25 years 20% during FY2013-2015. We expect some pressure on PAT due to increase in
Stable Firm provisioning on account of increasing NPA in the coming years.

Growth till perpetuity 3% Equity Cost: The book value is expected to increase 17% , in line with FY 12 .
Payout ratio 84%
Excess Returns: It is observed that HDFC bank gives returns in excess of
cost of equity 16.72% investor expectations during economic upswing. The excess returns have been
Target P/BV 3.8x estimated till FY 2015, after which we assumed a nominal growth of 15% in PAT
and a ROE of 17% to estimate the book value for next 22 years. The bank is
FY13E Book Value per share 148
then expected to grow at 3% till perpetuity.
Target Price Rs. 561
Go rdon Growth Mode l:
Source: Team Estimates
The value per share using Two stage Gordon growth model is Rs 568. The
7
P/B vs ROA methodology followed to arrive at the intrinsic price is as follows:
6 Kotak
Bank
5 HDFC
Bank
4
P/BV

3 Yes Bank

2 Axis Bank Two stage is appropriate to value the bank as its revenues are growing at more
SBI ICICI Bank
1 than 20% YoY .We expect the high growth to continue for at least 25 years as
there is huge potential for the Indian economy to grow and mature. The
0 perpetual growth rate is estimated to be 3%.
0.80 1.30 1.80 2.30
ROA Re lat ive Valuatio n Method:
Source: Annual Report
Sensitivity Analysis Gordon Growth We have compared HDFC bank with ICICI bank and Axis bank as these banks
Model are comparable in terms of the customers they cater to within the Indian
Rs. Payout Ratio markets. The multiples used to value the bank are P/BV , P/E and P/Total
561. Asset as these are primary drivers for a bank.
391 20% 21% 22% 23% 24% 25%
Growth in EPS

15% 239 245 251 257 263 269 We have not considered the price from relative valuation in the final value as
HDFC bank commands a premium compared to its peers in all the three
16% 282 289 295 302 308 315 multiples used .
17% 334 341 349 356 363 370
Final Price:
18% 396 404 413 421 429 437
19% 471 480 489 499 508 517 Residual income model is a stable model which gives maximum value to the
current book value and the impact of terminal value is minimal. However
20% 561 572 582 592 603 613 Gordon growth model is extremely sensitive to its inputs and sensitivity
analysis shows volatility in the target price. Hence we assign a weight of 70%
Source: Team Estimates to the value using Residual income model and 30% to Gordon growth model.

8
Corporate Governance & CSR (see Appendix 5)

HDFC ICICI Axis


We believe that Corporate Governance (CG) and Corporate Social
Independence
of the Board of 55% 67% 55% Responsibility (CSR) could enhance the potential of the bank, and
Directors consequently its long term value. We performed an assessment of HDFC
Independent Bank in these areas of interest.
Complied Complied Complied
Committees
Transparency Corporate Governance:
and Complied Complied Complied
Accountability The bank was among the first four companies, which subjected itself to a
Whistle Blower
Complied Complied Complied Corporate Governance and Value Creation (GVC) rating by CRISIL. The rating
Policy
Compensation provides an independent assessment of an entity's current performance
Complied Complied Complied and an expectation on its "balanced value creation and corporate
Structure
Means of governance practices" in future. The bank has been assigned a 'CRISIL GVC
communicatio Available Available Available Level 1' rating, which indicates that the bank's capability with respect to
n: Half yearly wealth creation for all its stakeholders while adopting sound corporate
Quarterly governance practices is the highest.
Available Available Available
reports
Available Available Available HDFC Bank follows Corporate Governance code pursuant to Clause 49 of
Annual report
the Listing Agreement entered into with the Stock Exchanges and also forms
Source: Team Estimates
a part of the report of the Board of Directors. Analyzing HDFC Bank, we have
identified areas in which the company complies with best practices and also
compared it with ICICI Bank and Axis Bank. - HDFC bank has been actively
involved in CSR activities and it was able to achieve mileage to its brand
name on account of its CSR activities. The CSR at HDFC bank is driven by
‘Changing Lives by empowering individuals through Finance, Education and
Training’. CSR at HDFC bank has been analyzed on account of Governance,
Community development, Employee welfare and Environment development.
We also performed a comparative study on account of CSR and HDFC bank
came out to be 2nd best in the sample. Details in Appendix.

Source: Team Estimates

Basel III Compliance (see Appendix 6)

HDFC bank should not have much issues to comply with the BASEL 3 guidelines issued by RBI. With a CRAR of 16.52% of which tier
1 accounts for 11.60% HDFC bank is almost sufficiently capitalized. Based on our estimates of growth in risk weighted assets at a
CAGR of 21% (FY13E -FY17E) and a growth in tier 1 capital at CAGR of 18% the bank would just be able to comply with the CRAR
requirement of 11.5% in FY17. The tier 1 capital estimated in FY17 which includes the capital conservation buffer ( CCB ) of 2.5% is
9.98% which is also above the 9.5% requirement stipulated by RBI.

Risk Analysis (see Appendix 7)

To understand the risk from a holistic perspective, we have analysed both the company risk and investment risk.

Company Risk: CAMELS Analysis

HDFC bank has been analyzed for its financial, operational and compliance stability using the CAMELS analysis. Based on our analysis
HDFC bank has received a B1 rating, the upper most rating in B category. The rating B indicates that the institution is fundamentally sound
and its operation are satisfactory. This reiterates the fact that HDFC bank does have a quality business. We believe HDFC Bank’s ability to
withstand stress is higher than other private sector counterparts because of its robust margins, strong funding structure and loan book
diversity.

Source: Team Estimates

9
Investment Risk Analysis (see Appendix 8)

In this section we analyze the main upside risks that could affect our target price

12 GDP vs Adv Growth 60% Strategic Risk


10 50% Strong growth in retail loan book - A strong growth in the retail loan
book of the bank, which has been its focus area, in spite of increasing
8 40% competition would help the bank maintain the 30% plus growth in PAT
GDP Growth

with robust loan growth. This would also help the bank to negate the
6 30% impact of wholesale loan growth which can affect the NIM negatively.
Both the above factors would impact the price positively.
4 20% Improvement in the NPA from historic low levels - An improvement in
GDP AdvGrowth % the NPL of the bank from historic low level of 0.9% GNPA in Q2FY13
2 10% would ensure that the provisioning required can be further reduced
resulting in a strong increase in PAT, positively impacting price. The
0 0% provisions for the quarter ended September 2012 were at historic low
2007 2008 2009 2010 2011 2012
levels of Rs 292.9 cr with a decrease of about 20% yoy.
Source: RBI
Continued and sustainable growth in non-interest income - Healthy fee
income growth of 20% plus, strong forex income and higher trading
12% gains would support the strong growth in non-interest income which
would positively impact the price.
10%
Macro risks
8%
Quick revival in the economy - The incremental credit growth of the
bank has a direct relation to the GDP. The credit growth of HDFC has
6% been at 3-4% above the 2.5X multiple of GDP growth on an average.
The current forecast on FY13 GDP numbers are between 4.9% to 5.3%.
Revival of the economy with a GDP growth rate exceeding expectations
4%
would result in robust credit growth.
Moderating inflation outlook - The inflationary tendencies are expected
2% Inflation (CPI) to persist with increase in diesel prices and retail inflation still hovering
around the double digit mark at 9.73% in September 2012. RBI with
the primary focus on containment of inflation and anchoring of inflation
0%
expectations is not expected to cut policy rates any time soon. But a
Sep-11

Sep-12
Jan-11
Mar-11

Jan-12
Mar-12
May-11

Nov-11

May-12
Jul-11

Jul-12

moderation in inflation numbers to 5% levels would tempt the central


bank to decrease the policy rates to revive the economy which in turn
Source: CSO would improve the NIM in banking sector.

Financial risks:

Fluctuations of exchange rates - Since HDFC banks operations are


confined to India, fluctuations in exchange rate wouldn't have a great
impact on the banks balance sheet in terms of transaction or
translation adjustments. On the revenue front in terms of non-interest
income it would have a positive impact on the forex income of the bank
as clients would use more forex and derivative products for hedging
the foreign exchange risk.
Source: RBI
Model Risk

Valuation risk - DCF valuation using Excess earning is used for the
valuation of HDFC bank. The assumption regarding the estimated P/BV
does have a major impact on the target price. For arriving at the
estimated P/BV we have taken the historical and the one
year average P/BV and calculated the weighted average of it. To
mitigate the risk, a Monte Carlo simulation was done with estimated
P/ABV and the weights assigned as the variable parameter assuming
log normal distribution and it was found that there is no major variation
Source: Team Estimates in the calculated target price. The mean and median values being Rs
590 and Rs 583 respectively.

In order to understand the impact of various risks getting triggered, on the valuation and hence the target price, we performed a
Monte Carlo simulation by assigning probability distributions to each risk affected parameter. Examination of analysis shows that the
standard deviation of target price is only Rs 20 with mean value of Rs 583 and median value of Rs 585. Details in Appendix 8B

10
Appendices

Appendix 1 A: Demographic Profile of India

A look into the demographical structure of the client base of the Indian banking industry shows very prominent trends
which can be used a fair estimate of the forthcoming scenario.

Firstly, an overview of the age-distribution of population predicts a younger population. Along with that it also shows an
expanding labour force, i.e. a growth in the working age group. Referring to the theory of demographic transition, we
see that India is poised at the growth phase. If we look at the graph given in the main text, we see a marked shift in
population towards working age. As of 2016 projections, India peaks in working age population. The high 0-4 age
group percentage implies a further expected increase in working age population in the next 15 years or so.

Largely for demographic reasons, urbanization in India is on a firmly upward path. And urban population growth is
occurring at the relatively fast pace that it is because the country is still at an intermediate stage in the demographic
transition.

New geographical markets are emerging. While the tier-I cities represent 6% of the population and account for 14% of
India’s GDP, tier-II represents about 7% of the nation’s population and contribute about 13% to GDP. Expansion into
these cities can be expected in the immediate future.

The fastest growing segment is the households earning more than Rs. 500,000 per annum. And the by scale the
largest sector in the coming decade will most likely be the households earning between 90000-200000 INR per
annum. This will contribute to income inequality in a particular band of incomes.
This shows the emergence of two very distinct (in terms of preference patterns) and important customer segments.
The former will increase the demand for wealth management and other related services. We can also expect the
number of HNIs to rise commensurately. The latter will want banks to provide easily accessible, mass-produced and
affordable products and services. The latter will also facilitate the need for expansion into tier II and III cities where the
growth in such populations can be expected.

Appendix 1 B

Macroeconomic Snapshot:

 concerns over global growth prospects and financial stability

 inflation, rising interest rates and policy impediments pulled down credit growth from 23% in 2011 to 16% in
2012

 Poor infrastructure project execution and subdued capex in areas such as power took infrastructure loan
growth lower to 18.8% in February, 2012 from 40.0% a year ago.

 Slow growth in monetary base increased structural drag on Inflation

 cyclical deterioration in asset quality remains a concern

 agriculture is likely to do well owing to low base and sufficient rainfall.

The Indian Economy is at a pivotal position in light of the political and economic issues it faces or is likely to face. The
trickle-down from the global economic crisis has affected the financial sector directly and the other sector indirectly
through the linkages.

The lack of confidence of the economic agents in the economy is compounded by expectation failure working through
the adaptive expectations framework. Constantly frustrated expectations are reflected in the popularity of the catch-
phrase policy paralysis. This has built in uncertainty and fickle sentiments in the system. This behavioural impact on
the economy could cost us dearly.
However, efforts to remedy this are in place by bona fide reforms and reshuffling of pre-existing signalling agents. This
is supposed to provide positive signals to global investors; however, many are sceptical about its immediate efficacy in
re-establishing the signalling framework. The government credibility will take time to get restored enough to improve
confidence, reinforce expectations and improve economic conditions.

The private banking sector in India has less or hedged exposures to external disturbances. The confidence in the
robustness of the banking sector has not led to any bank runs. Also, the faltering stock markets make the safe
instruments offered by banks more attractive.

In the long term, however, banks have other prospects and issues to tackle with.

Appendix 1 C

Mortgage Market

1. There could be a bourgening market for real estate and hence for mortgages. The India Infrastructure Report
2006 predicts a growth in Urban population which could be a contributing factor to increase in mortgage
business. FICCI-BCG predicts that mortgages will cross 40 trillion by 2020. The reasons why this forecast may
be creditable is:
a. Total mortgages have grown from 1.5% to 10% of total bank advances from 2000-20101
b. Mortgages are 7.7% of GDP currently, with the demographic trend towards urbanisation and rise in
the working-age population; we can expect a significant rise in this percentage. If this crosses 20%
by 2020, mortgages could grow to 40 trillion while currently the entire loan book of the banking
sector is 30 trillion.
c. Demographic reasons as discussed above.

Appendix 1 D

Sectoral Review

Power Sector

The CCEA has approved a restructuring plan that will remain open, in the first instance, till December 2012. Under this,
participating states will take over half the distribution companies’ outstanding debt; the rest will be restructured by
lenders. The immediate effect of the restructuring is the stress on banks. According to Standard & Poor’s, bank credit
to the power sector rose to Rs 3.3 lakh cr in March 2012 — 7.2 per cent of all bank lending. Meanwhile, SEB
distribution companies have run significant losses, casting doubt over their ability to repay and thus over financial
sector stability. In the same month, March 2012, the accumulated losses of discoms stood at Rs 2.46 lakh cr; and the
short-term debt of the seven states that accounted for 75 per cent of total debt liability (Rajasthan, Uttar Pradesh,
Madhya Pradesh, Andhra Pradesh, Punjab, Haryana and Tamil Nadu) was Rs 1.2 lakh cr.

These restructurings necessitate tariffs to be linked to the costs. However, how likely the SEB discoms are to honour
their debt is uncertain owing to the political nature of tariff revisions and the risk of moral hazard.

Auto Sector

Due to many and varied factors such as high inflation, economic uncertainty and high fuel prices the September 2012
auto sales in the country have shown the steepest monthly fall in four years. This implies that the Auto Industry can
miss the government’s Automotive Mission plan Target for FY16. SIAM has revised the growth forecasts from 11-13%
to 5-7%.

This does not spell well for the bank lending to auto sector and especially HDFC Bank which has around 40% exposure
of loan portfolio to this sector.

1
Indian Banking 2020:Making the Decade’s Promise Come True
Appendix 2: Competitor Ratios

Comparison of
Ratios HDFC Bank ICICI Bank AXIS Bank YES Bank Kotak Bank SBI
Burden efficiency ratio 0.76% 0.15% 0.16% 0.09% 1.31% 0.66%
Cash cover-age ratio 5.54% 4.68% 4.21% 3.68% 3.09% 5.04%

GNPA 2003.17 10,607.00 1,806.30 83.86 699.74 49,648.70


GNPA to Gross
advance 1.02% 3.58% 1.04% 0.22% 1.29% 4.18%

NNPA 354.19 2,692.00 472.64 17.46 273.43 21,095.09


NNPA to Net advance 0.18% 0.92% 0.28% 0.05% 0.51% 1.81%
Total business growth
ratio 1.20 1.11 1.18 1.09 1.31 1.14
Priority sector ratio 32.68% 20.29% 28.56% 25.92% 23.19% 29.71%
Aggregate deposits
(Rs. Cr.) 2,46,706.45 2,81,950.47 2,19,987.68 49,151.71 36,460.73 14,14,689.40
Average working funds
(awf) 3,07,631.05 5,68,979.64 263991.58 66334.54 83015.26 1738927.21

Working funds 3,37,909.50 6,04,191.41 2,85,416.51 73,662.11 92,349.39 18,29,956.17

Net profits 5,167.02 7,937.63 4,218.51 977.00 1,850.53 15,973.31

Operating profits 8,950.35 12,092.99 7,413.02 1,540.22 2,755.24 40,857.24

Total debt 2,70,552.95 4,43,247.10 2,54,059.35 63,308.19 65,655.42 15,72,680.76

Net worth 29,924.37 61,276.50 22,681.71 4,676.64 12,935.87 1,06,230.01

Total debt to net worth 9.04 7.23 11.20 13.54 5.08 14.80

Gross advances 1,95,420.03 2,92,125.42 1,69,759.54 37,988.64 53,143.61 11,63,670.21

Invest-ments 97,482.91 2,39,864.09 92,921.44 27,757.35 31,658.43 4,60,949.14

Interest income 27,286.30 37,994.86 21,994.90 6,307.36 8,470.42 1,47,197.39


Interest income to
average working funds 8.87% 6.68% 8.33% 9.51% 10.20% 8.46%

Non-interest income 5,243.69 28,663.42 5,487.19 857.12 4,543.40 29,835.44


Non-interest income to
average working funds 1.80% 5.04% 2.08% 1.29% 5.47% 1.72%

Operating expenses 8,590.06 29,552.05 6,099.89 932.53 5,716.62 46,856.03


Interest spread 8.42% 7.46% 7.46% 9.19% 10.22% 6.88%

Net spread 8,950.35 12092.9851 7,413.02 1,540.22 2,755.24 40,857.24

Risk weighted assets 2,41,896.32 4,41,488.00 2,31,711.39 51,982.63 74,279.29 11,12,982.46


Net profit to awf 1.68% 1.40% 1.60% 1.47% 2.23% 0.92%
Net profit to net worth 17.27% 12.95% 18.60% 20.89% 14.31% 15.04%
Operating profits to net
worth 29.91% 19.74% 32.68% 32.93% 21.30% 38.46%
Capital adequacy ratio 16.52% 19.60% 13.66% 17.90% 17.92% 13.68%
Tier I 11.60% 12.80% 9.45% 9.90% 16.54% 9.65%
Tier II 4.92% 6.80% 4.21% 8.00% 1.38% 4.03%

Business 4,42,126.48 574075.89 389747.21 87,140.35 89,604.34 25,78,359.61


Equity multiplier 1129.21% 9.86 12.58 15.75 7.14 17.23
NIM 3.92 2.26% 2.90% 2.33% 4.45% 3.30%

Net Interest Income 12,296.72 12,981.61 8,025.72 1,615.64 3,928.46 57,877.83


CASA Ratio 48.40% 42.13% 41.55% 14.96% 31.36% 40.69%
Slippage Ratio 0.98% 1.22% 1.09% 0.17% 0.67% 2.90%
Profits per employee
(Rs. Cr.) 0.08 0.09 0.14 0.2 0.09 0.05
ROA 1.68 1.47 1.61 1.42 1.86 0.91
ROE 18.69 11.2 20.29 19 11.37 15.72

Source: Team estimates, livemint.com, capitaline.com


Appendix 3 A

Income Statement (Rs. Cr.)

(Rs in Crs)
Year FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13 (E) FY 14 (E) FY 15 (E)
INCOME :
Interest Earned 6,648 10,115 16,332 16,173 19,928 27,286 32,681 38,869 46,644
Interest on advances 4,334 6,967 12,137 12,098 15,085 20,537 24,010 27,914 33,198
AVERAGE YIELD ON
ADVANCES 12.62% 14.96% 10.77% 10.56% 11.56% 11.18% 10.87% 10.86%
Income on investments 2,058 2,872 4,008 3,981 4,675 6,505 8,484 10,768 13,259
AVERAGE YIELD ON
INVESTMENTS 7.18% 7.41% 6.78% 7.22% 7.72% 7.51% 7.38% 7.28%
Interest on investment with RBI
and Banks 253 272 184 81 148 137 137 137 137
Other Income 1,516 2,283 3,291 3,983 4,335 5,244 6,469 7,540 8,509
II. Expenditure
Interest expended 3,179 4,887 8,911 7,786 9,385 14,990 17,800 20,149 23,670
COST OF FUNDS 4.64% 5.86% 4.32% 4.21% 5.54% 5.44% 5.19% 5.10%
Interest on Deposits 2,695 4,383 8,015 6,998 8,028 12,690 15,309 17,450 20,743

Interest on RBI / Inter-bank


borrowings (including
subordinated debt) 274 242 885 746 1,336 2,253 2,433 2,628 2,838
Other interest 210 262 11 43 20 47 58 71 89

Net Interest Income 3,468 5,228 7,421 8,387 10,543 12,297 14,881 18,719 22,974
NIM 4.10% 4.24% 3.91% 4.05% 4.20% 4.06% 4.20% 4.29%
Net Income 4,985 7,511 10,712 12,370 14,878 17,540 21,350 26,260 31,483
Operating expenses 2,421 3,746 5,533 5,940 7,153 8,590 10,664 12,934 15,689
Operating Profit - pre
provisioning 2,564 3,765 5,179 6,430 7,725 8,950 10,686 13,326 15,793
% growth 46.86% 37.54% 24.15% 20.15% 15.86% 19.39% 24.70% 18.51%
Provisions & Contingencies 925 1,485 1,880 2,141 1,907 1,437 1,629 2,367 2,684
% growth 60.5% 26.6% 13.9% -10.9% -24.6% 13.4% 45.3% 13.4%
Pre Tax Profit 1,639 2,281 3,299 4,289 5,819 7,513 9,057 10,959 13,109
Provision for Tax 497 690 1,054 1,340 1,892 2,346 2,828 3,423 4,094
PAT 1,141 1,590 2,245 2,949 3,926 5,167 6,228 7,537 9,015
% growth 39.31% 41.17% 31.36% 33.15% 31.60% 20.54% 21.00% 19.62%
Net profit margin 12.83% 11.44% 14.63% 16.18% 15.88% 15.91% 16.24% 16.35%
Dividend per share 1.40 1.70 2.00 2.40 3.30 4.30 5.28 6.34 7.52
Source : Annual Report, Team Estimates
Appendix 3B: Balance Sheet

Year FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15
TOTAL LIABILITIES &
SHAREHOLDERS EQUITY
Capital 319 354 425 458 465 469 469 469 469
Equity share warrant 400.92
Reserves and surplus 6114 11143 14221 21062 24911 29455 34438 40467 47679

Employees’ Stock Options (Grants)


Outstanding 5 3 3 0 0.30 0.30 0.30

Equity 6433 11497 15053 21522 25379 29925 34907 40937 48149
Deposits 68298 100769 142812 167404 208586 246706 296769 351447 417370
Borrowings 2815 4479 9164 12916 14394 23847 30160 36954 46300
Other Liabilities & Provisions 13689 16432 16243 20616 28993 37432 43443 52330 60417
TOTAL LIABILITIES 91236 133177 183271 222459 277353 337909 405280 481668 572236
ASSETS:
Cash & Balances with RBI 5075 12553 13527 15483 25101 14991 14255 11366 11819
Balances with Banks & money at
Call 3971 2225 3979 14459 4568 5947 3876 3365 2574
Investments 30565 49394 58818 58608 70929 97483 128541 163147 200888
61.6% 19.08% -0.36% 21.02% 37.44% 31.86% 26.92% 23.13%
Advances 46945 63427 98883 125831 159983 195420 234243 279141 331982
35.11% 55.90% 27.25% 27.14% 22.15% 19.87% 19.17% 18.93%
Fixed Assets 967 1175 1707 2123 2171 2347 2644 2927 3251
Other Assets 3713 4403 6357 5955 14601 21722 21722 21722 21722
TOTAL ASSETS 91236 133177 183271 222459 277353 337909 405280 481668 572236
Source: Annual Report, Team Estimates
Appendix 3 C: Financial Ratios

2012 2013(E) 2014(E) 2015(E)


NIM 4.20% 4.06% 4.20% 4.29%
YOY Growth
Deposits 18.28% 20.29% 18.42% 18.76%
Loans 22.15% 19.87% 19.17% 18.93%
Net interest Income 16.63% 21.01% 25.80% 22.73%
Fee Based income 18.87% 15.00% 15.00% 10.00%
Non interest income 31.04% 60.43% 21.50% 21.39%
Operating Revenue 17.89% 21.72% 23.00% 19.89%
Operating Expense 20.09% 24.14% 21.29% 21.31%
Pre provisioning operating Profit 15.86% 19.39% 24.70% 18.51%
Pre Tax Profit 31.60% 20.54% 21.00% 19.62%
PAT 31.60% 20.54% 21.00% 19.62%
EPS 22.11 26.42 31.70 37.61
DPS 4.30 5.28 6.34 7.52
ROA 1.68% 1.54% 1.56% 1.58%
Tier I leverage ratio 11.29 11.61 11.77 11.88
ROE 18.69% 17.84% 18.41% 18.72%
Asset Quality
GNPA (%) 1.02% 1.05% 1.14% 1.19%
NNPA (%) 0.18% 0.21% 0.24% 0.25%
Slippage Ratio (%) 0.81% 0.91% 1.00% 1.00%
NPA reduction rate (%) 38.84% 39.67% 39.28% 39.09%
Write off rate (%) 28.79% 30.00% 30.00% 30.00%
Upgradations (%) 0.10% 0.10% 0.10% 0.10%
Capital Adequacy Ratio
CAR (%) 16.52% 15.48% 15.33% 15.22%
Tier 1 (%) 11.60% 11.48% 11.33% 11.22%
Tier 2 (%) 4.92% 4.00% 4.00% 4.00%
Leverage (x) 11.3 11.6 11.8 11.9
Risk weighted assets / Total Assets
(%) 76.34% 75.00% 75.00% 75.00%
Solvency Ratios
Net NPA 0.18% 0.21% 0.24% 0.25%
Provision Coverage Ratio 82.38% 80.48% 79.51% 78.76%
Liquidity Ratios
CASA Ratio 48.40% 46.47% 45.82% 45.31%
Funding volatility Ratio 0.85 0.86 0.86 0.86
liquid Asset to Total Asset 41.28% 38.24% 38.43% 38.00%
Profitability Ratios
NII/Working Funds 3.64% 3.67% 3.89% 4.01%
Non Interest Income / Working
Funds 1.55% 1.60% 1.57% 1.49%
Productivity
Business per employee (in lakhs) 669 719 772 850
7.82
Profit per employee (in lakhs) 8.43 9.23 10.22
Source: Annual Report, Team Estimates
Appendix 4A: Residual Income Model

Cost Of Equity Calculation:

Risk free rate 8.20%


Market Risk Premium 9.00%
Beta 0.95
Cost of Equity 16.75%
Year of Valuation 2012
Terminal growth rate 3%
Source: Team Estimates
Source:Team Estimates

Residual Income Calculation :

FY FY FY FY
2012 2013(E) 2014(E) 2015(E)
Cost of Equity 16.75%
Net Income 5,167.02 6,228.49 7,536.57 9,015.28
- Equity Cost (see below) 5012.4 5847.0 6856.9 8064.9
Excess Equity Return 154.64 381.49 679.66 950.33

Beginning BV of Equity 29,924.7 34,907.5 40,936.7 48,148.9


Cost of Equity [%] 16.75% 16.75% 16.75% 16.75%
Equity Cost on Book Value 5012.4 5847.0 6856.9 8064.9

Intrinsic value of HDFC Bank on March


2012 39,645.9
Value per share as on March 2013 588.7
Intrinsic value of HDFC securities 2.2
Intrinsic value of HDB per share 2.1
Expected value per share 593

Source: Annual Report,


Team Estimates
Appendix 4B: Gordon Growth Model: Derivation

Since D0 = Payout *EPS,

We see that is akin to the of a Finite Geometric Progression, which follows the
formula:

Where a=1 and r= ;

Substituting we get,
Appendix 4C: Valuation of Subsidiaries:

We have used discounted cash flow method to value HDFC securities LTD it being a stable generator of cash and
Gordon growth Model for HDB financial services Ltd. The value we arrived at Rs. 2.17 and Rs. 2.13 for HDFC securities
and HDB financial services ltd respectively.

Assumptions:

HDFC Securities Ltd:

Revenue Growth: Growing at 10% for first four years and then declining linearly to 3%.

Terminal Growth: 3% p.a.

For calculating WACC, we have used CAPM model in which beta has been taken of comparable brokerage houses
(edelweiss) i.e. 1.1

HDB Financial Services Ltd:

Loan Book Growth: Over the past couple of years it has grown substantially at over 100%, but because of higher base
effect we have factored a growth of 50%, 40% and 30% for the next three years.

Valuation Based on Current Market Price of 62 8

CMP 628
Valuation Based on current Market
Price 2012 2013(E) 2014(E) 2015(E)
P/E 28.40 23.77 19.81 16.70
P/BV 4.90 4.24 3.65 3.13
BVPS 128.06 148.08 172.20 200.85
DPS 4.30 5.28 6.34 7.52

Source: Annual Report, Team Estimates


Appendix 4D: Estimates

1. Number of
Branches and ATMs
FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13(E) FY 14(E) FY 15(E)
Number of
Employees 21,477 37,836 52,687 51,888 55,752 66,076 73,876 81,676 88,176

Addition 16,359 14,851 -799 3,864 10,324 7,800 7,800 6,500

Branch Wise 49.7 37.3 30.1 28.1 26.0 26.00 26.00 26.00

Branches 684 761 1,412 1,725 1,986 2,544 2,844 3,144 3,394

Branch Addition 77 651 313 261 558 300.00 300.00 250.00


11.26% 85.55% 22.17% 15.13% 28.10% 11.79% 10.55% 7.95%

ATM 1,605 1,977 3,295 4,232 5,471 8,913 12,413 16,413 20,413

ATM Addition 372 1,318 937 1,239 3,442 3500.00 4000.00 4000.00

2,289 2,738 4,707 5,957 7,457 11,457 15,257 19,557 23,807


Growth 19.6% 71.9% 26.6% 25.2% 53.6% 33.2% 28.2% 21.7%

2. Deposits (Rs in cr)

Demand deposit 19,811.8 28,759.7 28,444.9 37,227.1 46,460.5 45,407.8 52,082.2 59,757.7 68,584.5

From Banks 695.4 844.7 759.2 1,055.5 1,018.5 912.2 912.2 912.2 912.2

From Others 19,116.5 27,915.0 27,685.7 36,171.6 45,442.0 44,495.6 51,170.0 58,845.5 67,672.3
Growth % 45.2% -1.1% 30.9% 24.8% -2.3% 15.0% 15.0% 15.0%

Savings Depo 19,584.8 26,153.9 34,914.7 49,876.8 63,447.8 73,998.0 85,837.7 1,01,288.5 1,20,533.3
Growth % 33.5% 33.5% 42.9% 27.2% 16.6% 16% 18.0% 19.0%

CASA Depo 39,396.7 54,913.6 63,359.7 87,103.9 1,09,908.3 1,19,405.9 1,37,920 1,61,046.2 1,89,117.8
Growth % 39.4% 15.4% 37.5% 26.2% 8.6% 15.5% 16.8% 17.4%
Proportion% 57.7% 54.5% 44.4% 52.0% 52.7% 48.4% 46.5% 45.8% 45.3%
28,901.3 79,451.9 2,28,252.0
Term Depo 45,855.0 80,300.6 98,678.1 1,27,300.6 1,58,849 1,90,400.7
Growth % 58.7% 73.3% 1.1% 22.9% 29.0% 24.8% 19.9% 19.9%

1,505.3 1,630.5 1,525.8 1,602.1


From Banks 1,519.6 1,382.4 1,426.8 1,384.0 1,453.2
Growth % 0.9% 7.3% -15.2% 3.2% -3.0% 5.0% 5.0% 5.0%

27,396.0 77,821.4 2,26,649.8


From Others 44,335.4 78,918.1 97,251.4 1,25,916.6 1,57,396 1,88,874.9
Growth % 61.8% 75.5% 1.4% 23.2% 29.5% 25.0% 20.0% 20.0%

Proportion% 42.3% 45.5% 55.6% 48.0% 47.3% 51.6% 53.5% 54.2% 54.7%

68,298 1,42,812 4,17,370


TOTAL DEPOSIT 1,00,769 1,67,404 2,08,586 2,46,706 2,96,769 3,51,447
Growth 47.5% 41.7% 17.2% 24.6% 18.3% 20.3% 18.4% 18.8%
3. Borrowings

(Rs in cr)

In India 2,815.4 4,478.9 9,163.6 12,915.7 14,394.1 23,846.5 30,160.3 36,953.6 46,299.6
RBI - - - - 120.0 40.0 44.0 48.4 53.2
-66.67% 10.0% 10.0% 10.0%

Other Banks 925.6 886.8 1,043.9 1,908.0 705.1 869.3 1,043.2 1,251.8 1,502.2
-4.20% 17.72% 82.78% -63.05% 23.30% 20.0% 20.0% 20.0%

Other Insti 155.7 0.2 5,645.1 7,526.3 927.0 2,818.2 3,241.0 3,727.1 4,286.2
Growth % -99.9% 2565844.7% 33.3% -87.7% 204.0% 15.0% 15.0% 15.0%

Sub-ordinated debts - - 0 0 6,947.1 10,596.9 10,596.9 10,596.9 10,596.9


52.54%

Outside India 1,734.1 3,591.9 2,474.6 3,481.4 5,694.9 9,522.0 15,235.3 21,329.4 29,861.1
107.1% -31.1% 40.7% 63.6% 67.2% 60.0% 40.0% 40.0%

Total Borrowing 2,815.4 4,478.9 9,163.6 12,915.7 14,394.1 23,846.5 30,160.3 36,953.6 46,299.6

4. Other Liabilities
and Provision (Rs in cr)

Bills Payable 3,678.1 3,157.2 2,922.4 5,925.7 5,636.1 5,465.7 5,739.0 6,026.0 6,327.3
Growth % -14.2% -7.4% 102.8% -4.9% -3.0% 5.0% 5.0% 5.0%

Interest Accrued 1,703.8 1,674.8 3,323.9 1,996.8 2,793.7 5,207.1 5,281.5 5,362.5 5,449.9
% of Term Deposit
and Borrowing 2.4% 1.6% 2.2% 1.1% 1.3% 1.9% 1.4% 1.5% 1.6%
Others (including
provisions) 8,307.2 11,600.0 9,996.5 12,693.4 20,563.0 26,759.1 32,422.4 40,941.8 48,640.1
% of total assets 8.7% 5.5% 5.7% 7.4% 7.9% 8.0% 8.5% 8.5%

13,689.1 16,431.9 16,242.8 20,615.9 28,992.9 37,431.9 43,442.9 52,330.3 60,417.3


Growth % -1.2% 26.9% 40.6% 29.1% 16.1% 20.5% 15.5%

5. Fixed Assets (Rs in cr)


A. Premises (
including land)
Gross Block

Opening 314.5 367.7 524.4 716.1 979.7 1,027.3 1,052.0 1,073.0 1,094.5

Additions/Deductions 53.2 156.7 191.6 263.7 47.6 24.7 21.0 21.5 21.9
% of opening 16.92% 42.62% 36.54% 36.83% 4.86% 2.40% 2.0% 2.0% 2.0%

Total 367.7 524.4 716.0 979.8 1,027.3 1,052.0 1,073.0 1,094.5 1,116.4

Depreciation 65.3 81.5 141.7 177.8 210.7 248.9 253.9 259.0 264.1
% of gross block 17.76% 15.54% 19.80% 18.15% 20.51% 23.66% 23.7% 23.7% 23.7%

Net Block 302.4 442.9 574.2 802.0 816.7 803.1 819.2 835.5 852.2
B. Other Fixed
Asset (including
furniture and
fixture)
Gross Block

Opening 1,231.1 1,506.0 1,818.8 2,779 3,273.6 3,762.2 4,423.6 5,087.2 5,850.2

Additions/Deletions 274.9 312.7 960.4 494.4 488.7 661.4 663.5 763.1 877.5
22.33% 20.76% 52.81% 17.79% 14.93% 17.58% 15.0% 15.0% 15.0%

Total 1,506.0 1,818.7 2,779.2 3,273.6 3,762.3 4,423.6 5,087.2 5,850.2 6,727.8

Depreciation 842 1,087 1,648 1,961 2,408 2,879 3,306.7 3,802.7 4,373.1
% of gross block 55.89% 59.74% 59.30% 59.89% 64.01% 65.09% 65.0% 65.0% 65.0%

Net Block 664.3 732.2 1,131.1 1,313.1 1,354.1 1,544.2 1,780.5 2,047.6 2,354.7

C. Assets on
Lease(Plant and
machinery)
Gross Block

Opening 43.8 43.8 43.8 461.4 454.7 454.7


Additions 417.5 -7 - -

Total 43.8 43.8 461.4 454.7 454.7 454.7 454.7 454.7 454.7

Depreciation

Opening 11.8 11.8 11.7 409.3 402.6 410.4


charge for the year 397.6 -6.7 7.8 -

Total 11.8 11.8 409.3 402.6 410.4 410.4 - - -

Lease adjustment
account 32.08 32.08 52.07 52.07 44.25 44.25 44.25 44.25 44.25

Gross Block 1917.58 2386.96 3956.51 4708.06 5244.27 5930.31 6614.90 7399.43 8298.86

Net Block 998.77 1207.18 1757.38 2167.14 2214.96 2391.51 2643.91 2927.37 3251.22

6. Investments (Rs in cr)

Government Sec 22,544 31,666 52,157 51,050 53,651 76,218 1,02,894 1,33,762 1,67,203
40.5% 64.7% -2.1% 5.1% 42.1% 35.0% 30.0% 25.0%

Approved Sec 0.7 0.6 1.3 0.5 0.5 0.5 0.5 0.5 0.5

Shares 58.3 34.5 39.7 103.5 93.5 83.6 92.0 110.4 132.4
-40.90% 15.30% 160.56% -9.69% -10.57% 10.0% 20.0% 20.0%

Debentures/Bonds 7,389.9 6,251.7 1,942.8 1,139.3 534.8 962.8 1,444.3 1,660.9 1,910.0
-15.4% -68.9% -41.4% -53.1% 80.0% 50.0% 15.0% 15.0%

Subsidiaries/JV 21.6 123.8 155.1 155.1 745.1 754.8 754.8 754.8 754.8

Others 550.0 11,317.2 4,521.8 6,112.1 15,815.8 19,462.7 23,355.2 26,858.5 30,887.3
1957.8% -60.0% 35.2% 158.8% 23.1% 20.0% 15.0% 15.0%
Net value of
investments 30,565 49,393 58,817 58,560 70,841 97,482 1,28,541 1,63,147 2,00,888
Growth % 61.6% 19.1% -0.4% 21.0% 37.6% 31.9% 26.9% 23.1%
Held to Maturity 19493.79 26010.11 39919.68 41754.32 41936.49 60424.25 77125 97888 120533
64% 53% 68% 71% 59% 62% 60% 60% 60%
Available for sale 10642.80 12407.46 12888.25 12125.58 26504.97 27775.37 38562.26 48944.23 60266.40
35% 25% 22% 21% 37% 28% 30% 30% 30%
Held for trading 428.21 10975.97 6009.62 4727.72 2487.91 9283.29 12854.09 16314.74 20088.80
1% 22% 10% 8% 4% 10% 10% 10% 10%
OUTSIDE INDIA
Shares - - - - 0.6 0.6 0.6 0.6 0.6

Debentures/Bonds 0.2 0.2 0.2 47.2 87.8 - - - -


Net value of
investments 0.2 0.2 0.2 47.2 88.4 0.6 0.6 0.6 0.6
Total value of
investments 30,564.8 49,393.5 58,817.5 58,607.6 70,929.4 97,482.9 1,28,541.5 1,63,148.0 2,00,888.6

7. Advances (Rs in cr)


TYPE

Bills Purchased 804.8 1,637.4 4,855.3 6,361.5 9,711.2 12,212.4 14,523.1 17,306.7 20,582.9
Growth % 103.5% 196.5% 31.0% 52.7% 25.8% 18.9% 19.2% 18.9%
Share % 2.6% 4.9% 5.1% 6.1% 6.2% 6.2% 6.2% 6.2%

Cash Credits 10,344.5 15,437.7 21,597.2 23,985.3 53,541.9 68,627.2 82,453.6 98,257.5 1,16,857.7
Growth % 49.2% 39.9% 11.1% 123.2% 28.2% 20.1% 19.2% 18.9%
Share % 24.3% 21.8% 19.1% 33.5% 35.1% 35.2% 35.2% 35.2%

Term Loans 35,795.5 46,351.8 72,430.5 95,483.9 96,729.6 1,14,580.4 1,37,266.6 1,63,576.4 1,94,541.5
Growth % 29.5% 56.3% 31.8% 1.3% 18.5% 19.8% 19.2% 18.9%
Share % 73.1% 73.2% 75.9% 60.5% 58.6% 58.6% 58.6% 58.6%

Secured by
Tangible Assets 32,845.4 42,662.9 73,467.8 89,232.8 1,17,492.9 1,42,059.8 1,70,294.9 2,02,935.3 2,41,350.9
Growth % 29.9% 72.2% 21.5% 31.7% 20.9% 19.9% 19.2% 18.9%
Share % 67.3% 74.3% 70.9% 73.4% 72.7% 72.7% 72.7% 72.7%
Covered by Bank/
govt guarantee 522.4 1,752.5 2,495.6 2,946.2 3,313.7 5,555.3 6,558.8 7,815.9 9,295.5
Growth % 235.5% 42.4% 18.1% 12.5% 67.6% 18.1% 19.2% 18.9%
Share % 2.8% 2.5% 2.3% 2.1% 2.8% 2.8% 2.8% 2.8%

Unsecured 13,577.0 19,011.5 22,919.6 33,651.6 39,176.0 47,805.0 57,389.6 68,389.5 81,335.6
Growth % 40.0% 20.6% 46.8% 16.4% 22.0% 20.0% 19.2% 18.9%
Share % 30.0% 23.2% 26.7% 24.5% 24.5% 24.5% 24.5% 24.5%
SECTOR (
Advances in India)

Priority Sector 17,683.1 17,426.3 29,781.6 44,157.6 54,781.2 63,863.0 78,232.2 93,878.6 1,11,715.5
Growth % -1.5% 70.9% 48.3% 24.1% 16.6% 22.5% 20.0% 19.0%
Share % 37.1% 47.0% 44.7% 43.5% 39.9% 40.0% 40.1% 40.0%

Public Sector 205.2 477.2 3,083.1 5,263.5 5,400.1 7,053.9 7,759.2 8,535.2 9,388.7
Growth % 132.6% 546.1% 70.7% 2.6% 30.6% 10.0% 10.0% 10.0%
Share % 0.8% 3.1% 4.2% 3.4% 3.6% 3.3% 3.1% 2.8%

Banks 38.3 8.8 366.7 622.9 28.6 371.4 375.1 378.9 382.7
Growth % -77.2% 4090.5% 69.9% -95.4% 1198.5% 1.0% 1.0% 1.0%
Share % 0.0% 0.4% 0.5% 0.0% 0.2% 0.2% 0.1% 0.1%

Others 29,018.2 45,514.7 64,818.3 73,808.2 95,119.2 1,18,210.2 1,41,852.2 1,70,222.7 2,04,267.2
Growth % 56.8% 42.4% 13.9% 28.9% 24.3% 20.0% 20.0% 20.0%
Share % 71.8% 65.6% 58.7% 59.5% 60.5% 60.6% 61.0% 61.5%
Total Advances
from India 46,944.8 63,426.9 98,049.7 1,23,852.2 1,55,329.1 1,89,498.5 2,28,218.8 2,73,015.3 3,25,754.1
Advances outside
India
Due from banks 0.00 0.00 0.00 0.00 1380.99 1841.86 1859.18 1876.65 1894.29
0.86% 0.94% 0.94% 0.94% 0.94%
Due from others 0.00 0.00 833.38 1978.43 3272.55 4079.70 4165.37 4248.68 4333.65
2.0% 2.1% 2.1% 2.0% 2.0%

Total advances 46,944.8 63,426.9 98,883.0 1,25,830.6 1,59,982.7 1,95,420.0 2,34,243.3 2,79,140.7 3,31,982.0
Growth % 35.1% 55.9% 27.3% 27.1% 22.2% 19.9% 19.2% 18.9%
Credit Deposit Ratio 68.7% 62.9% 69.2% 75.2% 76.7% 79.2% 78.9% 79.4% 79.5%

8. Cash and
Balances with RBI
Cash in hand
(including foreign
currency) 639.28 940.09 1,586.19 2,435.26 2,997.95 4,306.96 4,684.9 2,791.4 3,319.8
% of Advances 1.5% 1.6% 1.9% 1.9% 2.2% 2.00% 1.00% 1.00%
Growth % 47.1% 68.7% 53.5% 23.1% 43.7% 8.8% -40.4% 18.9%
Balances with RBI
In current account 4335.97 11513.09 11841.02 12948 22002.86 10484.13 9369.73 8374.22 8299.55
% of Advances 9.24% 18.15% 11.97% 10.29% 13.75% 5.36% 4.00% 3.00% 2.50%
In other account 100.00 100.00 100.00 100.00 100.00 200.00 200.00 200.00 200.00

Total 5075.25 12553.18 13527.21 15483.28 25100.82 14991.09 14254.60 11365.63 11819.37

10. Interest
Received (Rs in cr)
Interest On
Advances 4,334.15 6,966.73 12,136.75 12,098.28 15,085.01 20,536.60 24,009.9 27,914.1 33,198.2
% of Advances 9.2% 11.0% 12.3% 9.6% 9.4% 10.5% 10.25% 10.00% 10.00%
Growth % 60.7% 74.2% -0.3% 24.7% 36.1% 16.9% 16.3% 18.9%

Income on
investments 2,057.53 2,872.04 4,007.96 3,981.29 4,675.44 6,504.50 8,483.70 10,767.73 13,258.61
% of Net
Investments 6.73% 5.81% 6.81% 6.80% 6.60% 6.67% 6.60% 6.60% 6.60%
Growth % 39.6% 39.6% -0.7% 17.4% 39.1% 30.4% 26.9% 23.1%
Interest on
investment with RBI
and Banks 252.94 272.39 184.26 80.96 148.08 137.10 137.10 137.10 137.10
Growth % 7.69% -32.35% -56.06% 82.91% -7.41%
Total Interest
Received 6,644.6 10,111.2 16,329.0 16,160.5 19,908.5 27,178.2 32,630.7 38,818.9 46,593.9
11. Other Income
(Rs in cr)
Commission
Exchange 1,292.4 1,714.5 2,457.3 2,830.6 3,596.7 4,275.5 4,916.8 5,654.3 6,219.8
Growth % 32.7% 43.3% 15.2% 27.1% 18.9% 15.00% 15.00% 10.00%
-
P/L Investments -68.4 241.8 382.6 345.1 52.6 -195.9 134.4 163.1 200.9
% of Investments 0.5% 0.7% 0.6% -0.1% -0.2% 0.10% 0.10% 0.10%
-
P/L Assets -1.1 0.7 4.2 4.0 0.8 1.5 1.5 1.5 1.5
P/L Exchange
transaction 190.4 283.1 598.6 610.2 920.8 1,265.4 1,518.5 1,822.1 2,186.6
Growth % 48.74% 111.43% 1.94% 50.91% 37.41% 20.00% 20.00% 20.00%
Dividend Income - 0.4 1.2 1.2 1.2 1.2
- - -
Misc Income 103.0 43.0 -152.0 17.7 129.4 -104.0 102.9 101.9 -100.9
Growth % -58.2% -453.3% 111.7% -830.3% 19.7% 1.00% 1.00% 1.00%

Non interest Income 223.9 568.7 833.30 977.02 737.99 967.03 1551.41 1884.89 2288.08

Total 1,516.2 2,283.2 3,290.6 3,807.6 4,335.2 5,243.7 6,469.4 7,540.4 8,509.0
Growth % 50.6% 44.1% 15.7% 13.9% 21.0% 23.4% 16.6% 12.8%

12. Interest Paid

Interest on Deposits 2,695.3 4,382.7 8,015.5 6,997.7 8,028.3 12,689.7 15,309.0 17,450.4 20,742.8
% of Deposits 4.5% 5.7% 4.2% 3.9% 5.2% 5.20% 5.00% 5.00%
Growth % 62.6% 82.9% -12.7% 14.7% 58.1% 20.6% 14.0% 18.9%

Interest on RBI and


other banks 274.05 242.43 884.76 745.5 1,336.4 2,252.9 2,433.1 2,627.7 2,838.0
% of Deposits 27.3% 37.0% 30.6% 54.7% 98.1% 102.9% 107.8% 112.9%
Growth % -11.5% 265.0% -15.7% 79.3% 68.6% 8.00% 8.00% 8.00%

Other Interest 210.08 261.96 10.89 43.1 20.3 47.0 58.1 71.3 89.5
% of Deposits 7.3% 0.1% 0.4% 0.1% 0.2% 0.20% 0.20% 0.20%
Growth % -95.8% 295.6% -52.8% 131.4% 23.6% 22.6% 25.5%
Total 3179.45 4887.12 8911.10 7786.30 9385.08 14989.58 17800.22 20149.49 23670.22

13. Operating
Expense
Payment to
Employees 776.9 1,301.4 2,238.2 2,289.2 2,836.0 3,399.9 4,079.9 4,895.9 5,875.0

Growth % 67.5% 72.0% 2.3% 23.9% 19.9% 20.00% 20.00% 20.00%

Depreciation 219.6 271.7 359.9 394.4 497.4 542.5 595.3 665.9 746.9
% of Gross Block 11.4% 9.1% 8.4% 9.5% 9.1% 9.00% 9.00% 9.00%
Other Opex 1424.30 2172.52 2934.70 3080.88 3984.54 4864.71 5988.46 7371.79 9067.30
Growth % 52.5% 35.1% 5.0% 29.3% 23.1% 23.10% 23.10% 23.00%

2,420.8 3,745.6 5,532.8 5,764.4 7,318.0 8,807.1 10,663.7 12,933.6 15,689.2


Growth % 54.7% 47.7% 4.2% 27.0% 20.3% 21.1% 21.3% 21.3%
14.Provisions and
Contingencies
Provision for wealth
tax 0.40 0.45 0.61 0.55 0.60 0.55 0.55 0.55 0.55
Provision for NPA 691.15 1026.37 1605.80 1938.93 763.02 651.58 936.97 1674.84 1991.89
% of Net Advances 1.62% 1.62% 1.54% 0.48% 0.33% 0.40% 0.60% 0.60%
Provision for
diminution in value of
non performing
investment 0.00 0.00 0 0.00 93.40 0.00 0.00 0.00
Provision for
standard assets 169.86 189.66 120.48 0.00 0.00 150.50 150.50 150.50 150.50
other provisions and
contingencies 63.75 268.30 152.82 201.11 1143.09 541.22 541.22 541.22 541.22
Total 925.16 1484.78 1879.71 2140.59 1906.71 1437.25 1629.24 2367.11 2684.16
Provision for Income
tax 497.30 690.45 1054.31 1340.44 1892.26 2346.07 2828.50 3422.52 4094.04
% of Operating Profit 30.27% 31.96% 31.25% 32.52% 31.23% 31.23% 31.23% 31.23%
Total Provisioning 1422.46 2175.23 2934.02 3481.03 3798.97 3783.32 4457.74 5789.64 6778.20

15. Asset Quality -


Non Performing
Assets (NPAs)
Gross NPA to
Gross Advances
(%) 1.41% 1.95% 1.41% 1.05% 1.02% 1.05% 1.14% 1.19%
Net NPAs to Net
Advances (%) 0.47% 0.63% 0.31% 0.19% 0.18% 0.21% 0.24% 0.25%

Opening balance 508.9 657.8 907.0 1,951.5 1,816.8 1,694.3 1,999.4 2,492.2 3,208.1
Additions during the
year 778.6 1,202.8 3,413.3 2,610.9 1,451.0 1,574.9 2,131.6 2,791.4 3,319.8
% of Advances 1.66% 1.90% 3.45% 2.07% 0.91% 0.81% 0.91% 1.00% 1.00%

Sub Total 1,287.5 1,860.5 4,320.3 4,562.4 3,267.7 3,269.2 4,131.0 5,283.6 6,527.9
Less:
Upgradations 66.21 252.35 197.08 234.24 279.14 331.98
% of Advances 0.1% 0.2% 0.1% 0.10% 0.10% 0.10%
Recoveries 144.83 430.76 152.53 131.45 165.24 211.35 261.11
% of Gross NPA 3.4% 9.4% 4.7% 4.0% 4.00% 4.00% 4.00%
Write Offs 2187.37 2248.67 1168.52 941.32 1239.30 1585.09 1958.36
% of Gross NPA 50.6% 49.3% 35.8% 28.8% 30.0% 30.0% 30.0%
Reductions during
the year (including
technical write off) (629.73) (953.55) (2332.20) (2745.64) (1573.40) (1269.85) (1638.78) (2075.57) (2551.46)
48.9% 51.3% 54.0% 60.2% 48.1% 38.8% 39.7% 39.3% 39.1%

Closing balance 657.8 907.0 1,988.1 1,816.8 1,694.3 1,999.4 2,492.2 3,208.1 3,976.4
37.89% 119.20% -8.62% -6.74% 18.00% 24.65% 28.72% 24.0%

Provision Coverage 67.09% 68.43% 78.42% 82.51% 82.38% 80.48% 79.51% 78.76%
GNPAs to Total
Advances (%) 1.38% 1.41% 1.95% 1.41% 1.05% 1.02% 1.05% 1.14% 1.19%
Movement of NPAs
(NET)

Opening balance 155.2 202.9 298.5 627.6 392.1 296.4 352.3 486.5 657.2
Net Additions during
the year 54.7 98.1 400.4 - 35.1 176.5 255.8 335.0 398.4
% of Gross NPA
Addition 7.02% 8.16% 11.73% 0.00% 2.42% 11.21% 12.00% 12.00% 12.00%
Reductions during
the year (including
technical write off) 6.97 2.47 71.32 235.57 130.76 120.55 121.62 164.29 211.11
% of Net NPA
Addition 10.20% 37.53% 30.61% 25.49% 20.00% 20.00% 20.00%

Closing balance 202.9 298.5 627.6 392.1 296.4 352.3 486.5 657.2 844.4
NNPAs to Net
Advances (%) 0.43% 0.47% 0.63% 0.31% 0.19% 0.18% 0.21% 0.24% 0.25%

Movement of
provision for NPAs

Opening balance 353.7 454.9 608.5 1,323.9 1,424.7 1,397.9 1,647.1 2,253.2 2,859.3
Provision made
during the year 723.9 1,104.7 3,012.9 2,651.3 1,415.9 1,398.4 2,108.2 2,512.3 2,987.8
% of advances 1.5% 1.7% 3.0% 2.1% 0.9% 0.7% 0.90% 0.90% 0.90%
Write offs/ Write
backs 622.76 951.08 2260.87 2550.45 1442.64 1149.30 1502.10 1906.17 2338.84
% of Total provision
for NPA 57.8% 61.0% 62.4% 64.2% 50.8% 41.1% 40.00% 40.00% 40.00%

Closing balance 454.9 608.5 1,360.5 1,424.7 1,397.9 1,647.1 2,253.2 2,859.3 3,508.3
Source: Annual Report, Team Estimates

Appendix 4E: Valuation of Subsidiaries I - HDFC Securities

Assumptions: 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Year 1 2 3 4 5 6 7 8 9 10
Revenue
Growth 10.0% 10.0% 10.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0%

Opeating
Expense/Sales 48.2% 48.2% 48.2% 48.2% 48.2% 48.2% 48.2% 48.2% 48.2% 48.2%
Tax Rate 33.9% 33.9% 33.9% 33.9% 33.9% 33.9% 33.9% 33.9% 33.9% 33.9%
Current
Assets/Sales 62.2% 62.2% 62.2% 62.2% 62.2% 62.2% 62.2% 62.2% 62.2% 62.2%

Current
Liabilities/Sales 75.8% 75.8% 75.8% 75.8% 75.8% 75.8% 75.8% 75.8% 75.8% 75.8%
Cost of Capital 19.0%
Terminal
Growth Rate 3.0%

Discounted
Cash Flow

Sales 231.011 254.1121 279.52331 307.47564 335.14845 361.96032 387.29755 410.5354 431.06217 448.304657

COGS + S&A 111.24078 122.36486 134.60135 148.06148 161.38701 174.29797 186.49883 197.68876 207.5732 215.876128

Operating Profit 119.77022 131.74724 144.92196 159.41416 173.76144 187.66235 200.79872 212.84664 223.48897 232.428529

Taxes 40.602104 44.662315 49.128546 54.041401 58.905127 63.617537 68.070764 72.15501 75.762761 78.7932712

NOPAT 79.168115 87.084926 95.793419 105.37276 114.85631 124.04481 132.72795 140.69163 147.72621 153.635258

Capex, net of
Dep. 0 0 0 0 0 0 0 0 0 0

Change in NWC -31.38661 -34.52527 -37.97779 -41.77557 -45.53537 -49.1782 -52.62068 -55.77792 -58.56682 -60.909489

Free Cash Flow 110.55472 121.61019 133.77121 147.14833 160.39168 173.22302 185.34863 196.46955 206.29303 214.544746
Terminal Value 1381.1318

Total Flows 110.55472 121.61019 133.77121 147.14833 160.39168 173.22302 185.34863 196.46955 206.29303 1595.67655

PV 92.903127 85.87684 79.381953 73.378276 67.212034 60.999157 54.847982 48.856185 43.108399 280.204592

Enterprise Value
as on 31 March
2011 886.76855

Less: Current
Debt 0

Equity Value as
on 31 March 886.76855

Equity Value on
30 September
2012 812.89939

HDFC Bank's
holding 0.6302

Value of HDFC
holding 512.2892
Source: Annual Report, Team Estimates
Intrinsic value
per share 2.17

Appendix 4F: Valuation of Subsidiaries II - HDB Financial Services

Components of Two Stage Model


High growth period 25
Payout 0.00%
Growth in EPS 20.00%

Stable Firm
Growth till perpetuity 3%
Payout ratio 82%

ROE 17%
cost of equity 21.65%

Final P/BV 0.5

Book value on FY13 915


No of Shares trading in HDFC bank 236
HDFC Bank stake in HDB 97.03%
Bv per share 4.00

Price based on Gordon growth model 2.13

Source: Annual Report, Team Estimates


Appendix 5: Corporate Governance and CSR Grading

The various parameters used to assess the quality of corporate governance are explained below:

 Independent Committees : The composition of all committees and their roles are disclosed very
effectively
 Transparency and Accountability: The cardinal principles such as independence, accountability,
responsibility, transparency, fair and timely disclosures, credibility, etc. serve as the means for
implementing the philosophy of corporate Governance.
 Whistle Blower Policy: The Bank has adopted the Whistle Blower Policy pursuant to which
employees of the Bank can raise their concerns relating to fraud, malpractice or any other activity
or event which is against the interest of the Bank or society as a whole
 Compensation Structure: The Compensation structure is disclosed adequately
 Means of communication: Half yearly reports, Quarterly reports, Annual report are made available.

Parameters considered for CSR ranking


Governance Community Employees Environment
Compensation Policy and
Board Product
and benefits Reporting

Leadership Human Rights Diversity and Resource


ethics and Supply Chain Labor Rights Management

Transparency Training, health


and Reporting and safety
Community
development

Overall Community Employees Environment Governance

HDFC Bank Ltd. 46 47 52 37 48


ICICI Bank Ltd 41 48 42 34 40
Axis Bank Limited. 47 49 57 35 50
Kotak Mahindra Bank 49 51 50 45 50
State Bank of India Group 41 47 48 36 35
Source: CSR hub, Team estimates
Appendix 6: Basel III Co mpliance

Transitional guidelines for Basel III implimenttion as suggested by RBI


2012-13(E) 2013-14(E) 2014-15(E) 2015-16(E) 2016-17(E)
Minimum Tier I 6.000% 6.500% 7.000% 7.000% 7.000%
Minimum Tier II 3.000% 2.500% 2.000% 2.000% 2.000%
CCB (Capital Conversion Buffer) 0.000% 0.625% 1.250% 1.875% 2.500%
Tier I + CCB 6.000% 7.125% 8.250% 8.875% 9.500%
Total 9.000% 9.625% 10.250% 10.875% 11.500%

Expected RWA's (Growing @ 21%) 3,12,147.19 3,77,698.10 4,57,014.70 5,52,987.79 6,69,115.22

Tier I capital (Estimates growth @ 18%) 34,898.38 40,866.68 48,134.63 56,695.13 66,778.09
Tier II capital - Maturities (Assuming no
new borrowings) 12,270.78 12,270.78 11,856.78 10,654.78 10,244.78

Tier I Capital to RWA 11.18% 10.82% 10.53% 10.25% 9.98%


Tier II Capital to RWA 3.93% 3.25% 2.59% 1.93% 1.53%
Total 15.11% 14.07% 13.13% 12.18% 11.51%

Source: RBI, Team Estimates


APPENDIX 7: CAMELS Methodology

 The rating A indicates that the institution is basically sound in every respect and it gives no
cause for supervising concern
 The rating B indicates that although the insitution is fundamentally sound and its operation are
satisfactory, it does reflect modest weakness for which the supervisory response is limited to
minor adjustments.
 The rating C exhibits a combination of financial, operational and compliance weakness ranging
from moderately severe to unsatisfactory

HDFC BANK

Total Ind
Weights HDFC Score Score W*IS W*S
Ratios for CAMELS Weight Score
CRAR 70% 18% 16.52% B1 7
C 15% B2 6 6.7 B2 1.206
D/E 9.04
COVERAGE RATIO 15% 8.75% B2 6
NNPA 10% 18% 0.18% A1 10
A GSEC/Total Investments 30% 78.19% A3 8 8.8 A3 1.584

Standard Adv / Total Advances 60% 98.30% A2 9

Business per employee 25% 18% 6.54 C2 3


M Profit per employee 25% 0.08 B3 5 6 B2 1.08

CDR 50% 0.33% A3 8

ROA 25% 10% 1.53 A3 8


NII/Total Assets 25% 3.60% A3 8
E 8 A3 0.8
Operating Profit / Total Assets 25% 2.65% A3 8

Cost / Income 25% 49% A3 8

Cash / Total Assets 25% 18% 4.40% A2 9


L Gsec/ Total Assets 25% 22.60% A3 8 7.25 B1 1.305

Liquid Assets / Total Deposit 50% 8.49% B2 6


S System and Control 100% 18% A3 8 8 A3 1.44
7.5 7.4
Rating B1 Rating B1
Adjusted B1 Adjusted B1
ICICI BANK

Total
Weights ICICI Score Score W*IS Ind Score W*S
Ratios for CAMELS Weight
CRAR 70% 18% 19.60% A2 9

C 15% A3 8 8.55 A3 1.539


D/E 7.23
COVERAGE RATIO 15% 9.70% B1 7
NNPA 10% 18% 0.92% B3 5

A GSEC/Total Investments 30% 41.42% B3 5 5.6 B3 1.008


Standard Adv / Total
60% 95.54% B2 6
Advances
Business per employee 25% 18% 7.08 C2 3
M Profit per employee 25% 0.09 B3 5 3.5 C2 0.63
CDR 50% 1.25% C2 3

25% 10% B1 7
ROA 1.47
NII/Total Assets 25% 2.15% B3 5
E 5.75 B3 0.575
Operating Profit / Total
25% 2.00% B2 6
Assets
Cost / Income 25% 70.96% B3 5
Cash / Total Assets 25% 18% 3.43% B1 7

L Gsec/ Total Assets 25% 16.44% B2 6 8.25 A3 1.485


Liquid Assets / Total
50% 14.60% A1 10
Deposit
S System and Control 100% 18% A3 8 8 A3 1.44
6.6 6.7
Rating B2 Rating B2
Adjusted C1 Adjusted C1
AXIS BANK

Total Ind
Weights Axis Score Score W*IS W*S
Ratios for CAMELS Weight Score
CRAR 70% 18% 13.66% B3 5

C 15% B3 5 5 B3 0.9
D/E 11.20
COVERAGE RATIO 15% 7.78% B3 5
NNPA 10% 18% 0.28% A2 9

A GSEC/Total Investments 30% 62.87% B1 7 7.8 B1 1.404


Standard Adv / Total
60% 97.97% A3 8
Advances
Business per employee 25% 18% 12.76 B2 6
M Profit per employee 25% 0.14 A3 8 6 B2 1.08
CDR 50% 0.77% B3 5

25% 10% A3 8
ROA 1.61
NII/Total Assets 25% 2.81% B2 6
E 7.5 B1 0.75
Operating Profit / Total
25% 2.60% A3 8
Assets
Cost / Income 25% 45.14% A3 8
Cash / Total Assets 25% 18% 3.75% A3 8

L Gsec/ Total Assets 25% 20.47% B1 7 6.25 B2 1.125


Liquid Assets / Total
50% 6.33% B3 5
Deposit
S System and Control 100% 18% A3 8 8 A3 1.44
6.76 6.70
Rating B2 Rating B2
Adjusted B2 Adjusted B2
YES BANK

Total
Weights Yes Score Score W*IS Ind Score W*S
Ratios for CAMELS Weight
CRAR 70% 18% 17.90% A3 8

C 15% C2 3 6.65 B2 1.197


D/E 13.54
COVERAGE RATIO 15% 6.33% C1 4
NNPA 10% 18% 0.05% A1 10

A GSEC/Total Investments 30% 58.29% B2 6 8.8 A3 1.584


Standard Adv / Total
60% 99.62% A1 10
Advances
Business per employee 25% 18% 17.48 A3 8
M Profit per employee 25% 0.2 A2 9 8.75 A3 1.575
CDR 50% 0.22% A2 9

25% 10% B1 7
ROA 1.42
NII/Total Assets 25% 2.19% B3 5
E 6.75 B2 0.675
Operating Profit / Total
25% 2.09% B2 6
Assets
Cost / Income 25% 37.71% A2 9
Cash / Total Assets 25% 18% 3.17% B1 7

L Gsec/ Total Assets 25% 21.96% A3 8 6.25 B2 1.125


Liquid Assets / Total
50% 7.29% B3 5
Deposit
S System and Control 100% 18% A3 8 8 A3 1.44
7.53 7.60
Rating B1 Rating B1
Adjusted B1 Adjusted B1
KOTAK BANK

Total
Weights Kotak Score Score W*IS Ind Score W*S
Ratios for CAMELS Weight
CRAR 70% 18% 17.92% A3 8

C 15% A2 9 8.45 A3 1.521


D/E 5.08
COVERAGE RATIO 15% 13.71% A1 10
NNPA 10% 18% 0.51% B2 6

A GSEC/Total Investments 30% 57.14% B2 6 7.8 B1 1.404


Standard Adv / Total
60% 98.29% A2 9
Advances
Business per employee 25% 18% 6.13 C2 3
M Profit per employee 25% 0.09 B2 6 7.25 B1 1.305
CDR 50% 0.02% A1 10

25% 10% B2 6
ROA 1.22
NII/Total Assets 25% 4.25% A2 9
E 7.5 B1 0.75
Operating Profit / Total
25% 2.98% A2 9
Assets
Cost / Income 25% 67.48% B2 6
Cash / Total Assets 25% 18% 2.20% B3 5

L Gsec/ Total Assets 25% 19.59% B1 7 7 B1 1.26


Liquid Assets / Total
50% 9.81% A3 8
Deposit
S System and Control 100% 18% A3 8 8 A3 1.44
7.67 7.68

Rating B1 Rating B1
Adjusted B1 Adjusted B1
SBI

Total Ind
Weights SBI Score Score W*IS W*S
Ratios for CAMELS Weight Score
CRAR 70% 18% 13.68% B3 5

C 15% C3 2 4.1 C1 0.738


D/E 14.80
COVERAGE RATIO 15% 4.65% C3 2
NNPA 10% 18% 1.81% C3 2

A GSEC/Total Investments 30% 78.11% A3 8 5.6 B3 1.008


Standard Adv / Total
60% 94.37% B3 5
Advances
Business per employee 25% 18% 7.98 C1 4
M Profit per employee 25% 0.05 B3 5 4.75 C1 0.855
CDR 50% 0.80% B3 5

25% 10% C3 2
ROA 0.91
NII/Total Assets 25% 3.16% B1 7
E 5.5 B3 0.55
Operating Profit / Total
25% 2.23% B2 6
Assets
Cost / Income 25% 53.42% B1 7
Cash / Total Assets 25% 18% 4.33% A2 9

L Gsec/ Total Assets 25% 19.68% B1 7 7.5 B1 1.35


Liquid Assets / Total
50% 9.02% B1 7
Deposit
S System and Control 100% 18% A3 8 8 A3 1.44
5.91 5.94
Rating B3 Rating B3
Adjusted C1 Adjusted C1
Appendix 8A

MONTE CARLO SIMULATION - P/BV estimate

For arriving at the estimated P/BV we have taken the historical and the one year average P/BV and
calculated the weighted average of it. The one year average P/BV was given a weight of 60% and the
historical average P/BV has been given a weight of 40%. This is done mainly because HDFC Bank has
always commanded a premium over the other banks due to its superior business quality. Further to
mitigate the risk the below Monte Carlo simulation was done with estimated P/BV and the weights
assigned as the variable parameter assuming log normal distribution and it was found that there is no
major variation in the calculated target price. The mean and median values being Rs 590 and Rs 583
respectively.

Forecast: Target Price

Statistics: Forecast
values
Trials 10,000
Mean 590.47
Standard Deviation 27.04
Coeff. of Variability 0.0458
Minimum 536.77
Maximum 991.81
Appendix 8B: Monte Carlo Simulation: Sensitivity of Target Price

In order to understand the impact of various risks presented in the report on the valuation and hence the
target price, we performed a Monte Carlo simulation by assigning probability distributions to each risk
affected parameter. Normal distribution and lognormal distribution are used to model each of the risk
affected parameter. For upside and downside risk log normal distributions were considered and for all
other parameter a normal distribution was considered as these would be random in nature. The variance
on each distribution is calculated from a combination of historical data and assumptions on the maximum
variance the parameter can get subjected to in the event the risk becomes operational. Only those risks
are considered which can be modeled with a certain level of confidence. The principal assumptions of the
Monte Carlo analysis are given in the following table.

Risk Affected parameter Distribution St Dev Comments

Strategic Risk
Retail Loan Growth Retail loan book Log Normal 2% Upside risk from strategic
growth above 20% success
GNPA improvement GNPA Improvement Normal 0.3% Downside risk from strategic
from 0.9% success
Growth in Non Interest NII Growth above Normal 2% Upside risk from strategic
Income expectation success
Macro Risk
Deposits growth Term Deposit Growth Log normal 2% Upside risk from economical
estimate revival
CASA growth Log normal 2% Upside risk from economical
estimate revival
Advances growth Advances Growth Log Normal 2% Upside risk from economical
estimate revival
Moderate Inflation Reduced cost of Normal 0.5% Upside risk from economical
funds revival
Financial Risk
Increased Forex gains Increase in Forex Normal 2% Upside risk from currency
Gains instability
Statistics: Forecast values
Trials 10,000
Mean 583
Median 585
Mode ---
Standard Deviation 20
Variance 406
Skewness -0.4761
Kurtosis 3.51
Coeff. of Variability 0.0345
Minimum 482
Maximum 644
Range Width 162
Mean Std. Error 0

Appendix 8C: Other Risks

Senior Management Attrition - Execution risk would arise if the bank observes significant attrition at the
senior management level. This would have a negative impact on the prices and would pull down the prices
further down.

No area for diversification: The biggest limiting factor for the bank is that it is under the ambit of HDFC Ltd
which carries out all the related financial business, where a bank can venture into. So the scope for
diversifying its business into other related areas is not present which is there with its other peers. However,
this gives a bank an opportunity to efficiently utilize its banking business and maintaining its performance
going forward.

Operational Risk - Risk arising due to disruption of banking services on account of IT and Core Banking
failure, or on account of reputation loss due to internal or external fraud or on account of natural calamity
or other unforeseen circumstances would impact the projected growth numbers of the bank and in turn will
have a negative impact on the price. HDFC bank has a prudent operational risk management in place
which include DRS ( disaster recovery sites ), internal and external fraud management and control
mechanisms and business continuity plan put in place in case of eventuality of above operational risk.
Appendix 9

SWOT Analysis

Strength

 Enjoying a well established brand name across the country.


 Strength and support of parent.
 Good and desirable composition of board, well qualified and independent directors.
 Continuity of top management - their intimate knowledge about organizational culture as well as
personal knowledge about the field functionaries.
 Loyalty of employees and banks ability to retain its pool of trained manpower.
 Implicit faith of the public in the bank.
 Substantially Wide network of branches

Weakness

 Less presence in rural and semi urban areas


 Profit per employee is low
 Less aggressive bank image and shrinking CASA ratio.

Opportunities

 Favourable market perception aiding ability to access capital markets


 CRAR much above regulatory minimum offering opportunities for expansion of business.
 Large deposit base( in absolute numbers) especially low cost deposit offering opportunities for
business expansion.

Threats

 Competition from new branches of banks which are more aggressive.


 New entrants in banks own niche segments
 "Excellent Past performance in your future enemy" - moderation in growth numbers which might
hamper the banks image.
Appendix 10: BETA Calculatio n

Beta Values
Monthly Weekly
1y 1.056591 0.943765
2y 0.726818 0.8051
3y 0.768971 0.86445
R2 Value
Monthly Weekly
1Y 0.88972 0.58492
2Y 0.063762 0.066837
3Y 0.086893 0.026377

1.2
1 Beta Values
0.8
0.6 Monthly

0.4 Weekly

0.2
0
1y 2y 3y

1
R sq Values
0.8

0.6
Monthly
0.4 Weekly

0.2

0
1Y 2Y 3Y
Disclosures:

Ownership and material conflicts of interest:


The author(s), or a member of their household, of this report does not hold a financial interest in the
securities of this company.
The author(s), or a member of their household, of this report does not know of the existence of any
conflicts of interest that might bias the content or publication of this report.
Receipt of compensation:
Compensation of the author(s) of this report is not based on investment banking revenue.
Position as a officer or director:
The author(s), or a member of their household, does not serve as an officer, director or advisory
board member of the subject company.
Market making:
The author(s) does not act as a market maker in the subject company’s securities.
Disclaimer:
The information set forth herein has been obtained or derived from sources generally available to
the public and believed by the author(s) to be reliable, but the author(s) does not make any
representation or warranty, express or implied, as to its accuracy or completeness. The information
is not intended to be used as the basis of any investment decisions by any person or entity. This
information does not constitute investment advice, nor is it an offer or a solicitation of an offer to
buy or sell any security. This report should not be considered to be a recommendation by any
individual affiliated with IAIP, CFA Institute or the CFA Institute Research Challenge with regard to
this company’s stock.

CFA Institute Research Challenge